For this assignment you will read each paragraph from part 1 and 2 and respond t

Question

For this assignment you will read each paragraph from part 1 and 2 and respond to the students forum with 200 words a piece with your thoughts about the statement.

1. My knowledge of pro forma statements is minimal as I have just learned about these statements through another class within this program. Pro forma statements provide hypothetical amounts that provide estimates and give an idea of the business’ profits if certain items are excluded, or including hypothetical projections. Some companies will use pro forma statements to convince investors that their company is in good standing and would be a smart investment. The benefits to pro forma statements are that they can provide a rosier picture to potential investors and provide various scenarios for the business to make smarter decisions in the future. The drawback to pro forma statements is that they can also be manipulated to show a skewed picture, leaving out some expenses that may flow through the company. (Investopedia, 2018)

There are a variety of ways pro forma statements can also be used to in an entrepreneur's advantage. They can be used to project the company's full year revenue, which would be helpful to present internally to managers and externally to investors. If a company is seeking additional funding to support their business, they can provide a projection showing how that investment would help their company's revenue. If a company has taken on any acquisitions in the past, they can use the pro forma statements to reflect on how that acquisition changed their financial statements, which could then affect their decision for a future acquisition. (Bragg, 2017)

Sometimes companies will exclude expenses that may only be temporary, so it doesn’t negatively affect their financial statements when presented to the investors. Sometimes companies may choose to omit line items like unsold inventory as it may look bad to investors, but it costs money to produce those goods even if they were not sold, which would be deceptive to outsiders looking in. This doesn't mean all pro forma statements are manipulated, but it is important to understand that these statements may not provide the entire picture, and that there should be more due diligence should an investor choose to invest in a company.

2. As an entrepreneurs starting a new business, there is need to know how much money is or will be needed to start the business, what expenses will be incurred at different sales level and how much money is expected to be made in a form of profit if any, by analyzing the feasibility of a business idea entrepreneurs can utilize pro forma financial statements to estimate or project the amount of capital the venture will require since new business don’t have historical financial data to compile actual financial statements. The pro-forma statements i.e., balance sheet, income statement and cash flow provide key figures for profitability analysis, forecasting and ration analysis.

Pro-forma statements should be evaluated and analyzed on a monthly basis to see if the projections make sense and if changes or updates are necessary. An accurate estimate of start-up capital is an important process to new business planning, creating a pro-forma statement allows the entrepreneur to have a better tool to run the business, pro-forma statements are necessary when looking for additional funding or  capital from investors to transform the business plan into reality (Wilkinson, (2013).

Any business that runs out of cash has a higher chance of failure; late payments to suppliers or workers reduce the new company's chances of survival, it is therefore necessary to have a cash flow projection that is up-to-date to avoid cash shortages. Cash flow projections help in identifying the main causes of cash shortages and how to reverse the cause.

A pro-forma balance sheet is a good tool to forecast the business future assets and liabilities and since pro-forma statements are projections, there is need to understand the difference in variance between the actual income statements and pro-forma income statement and make adjustment where necessary, for example if sales are less than projected, it may be a good idea to review and analyze why projections and actual income statement are too far apart and if there is need to apply reduction on the expenses (Business Town, n.d.).

Explanation / Answer

1. The first statement accurately points out that pro forma financial statements are based on certain assumptions and projections. Usually and in most cases pro forma financial statements take out one time charges from the financials. The purpose of taking out one-time charges from the financial statements is to smoothen the earnings of an organization. This is of great help to entrepreneurs as a company, in its initial stages, incurs several onetime charges and by removing these onetime charges the pro forma financial statements enables a better comparison on a year to year basis or a month to month basis or a quarter to quarter basis. In simple words pro forma financial statements usually excludes those items that may obscure the accuracy of its financial outlook. Thus it is on the basis of a pro forma financial statement that future prospects of a company can be better assessed. Entrepreneurs find this more useful as estimated relevance of certain events are considered.

On the flip side pro forma financial statements can be used to manipulate financial statements and to provide a picture of the financial health and position of the company that is much better than the actual health and position. (200 words)

2. For an entrepreneur forecasting of future sales and costs are highly important as it on this basis that an entrepreneur chalks the future plans and strategy for his company. It is here that pro forma financial statements come in real handy for an entrepreneur. An entrepreneur can develop projected or future financial statements. The purpose is to write down a sequence of financial statements that will be truly representative of expectations with regards to actions and policies being taken by the entrepreneur and its financial impact on the firm. The pro forma financial statements (pro forma income statements, balance sheets and cash flow statements) will serve as the building block of financial analysis and planning for an entrepreneur.

Going forward entrepreneurs can use pro forma financial statements to obtain external financing in the form of bank loans and in the form of investments by investors, private equity companies etc. An entrepreneur will also be able to determine the optimum amount of cash balance that has to be maintained so that there is no shortage of cash. Holding excess cash is also not desirable and so an entrepreneur will be able to determine, using the pro forma financial statements, to determine optimal cash levels. (204 words)

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